Plus, the most undervalued sectors after the stock market’s rotation.
Hello, and welcome to The Morning Filter. Every Monday, Susan Dziubinski sits down with Morningstar Chief U.S. markets strategist Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead.
Key takeaways:
00:05 Tariff Uncertainty & The Market
05:43 On Radar: Inflation & Key Earnings
10:09 New Research & Undervalued Sectors
20:48 Stocks of the Week
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Susan Dziubinski: Hello and welcome to The Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning I talk with Morningstar Research Services' chief US market strategist Dave Sekera, about what investors should have on their radars, some new Morningstar research and a few stock picks or pans for the week ahead. Now, before we get started, Dave and I wanted to let our audience know that we’re putting together a special viewer and listener mailbag episode of The Morning Filter, so send us your questions at The Morning Filter at morningstar.com and we’ll answer as many as we can. And as a reminder, Dave cannot give personalized portfolio advice.
All right, Dave, good morning. Before we get to the week ahead, let’s first talk about last week’s market activity. Stocks finished the week down more than 3% on tariff uncertainty. What’s your take on the market’s response to the fluid tariff situation?
David Sekera: Good morning, Susan. Yes, the headlines are all about tariffs, but I think the market reaction is really much more than just being only about the tariff situation. If you remember in our 2025 outlook, we had noted that valuations were getting too stretched coming into the year. The market was trading at about a 4% premium over a composite of our fair values, and we also had talked about how those tailwinds that had propelled the markets in 2024 were all slowing coming into this year, and, of course, we are looking at the rate of economic growth slowing. We’re expecting three sequential quarters of growth slowing this year as well. Then on top of all of that, you add in the added uncertainty from the tariff situation. So, again, I think there’s a lot more going on here than just the tariffs in and of themselves.
And then also, I was looking at the charts over the weekend, and I think there’s also some concern in the market about the potential impact from the focus on cutting government spending. If you were to look at government spending or federal spending as a percent of GDP, I think it was 24% in 2024. Looking back further, it was only 20% prepandemic, and even before that, it was lower, probably in the upper teens going back toward the global financial crisis and before that. Having said all that, I think investors also need to look below the surface. When I take a look at the market over the course of the year, coming into the year, we had recommended to overweight value, underweight growth. Right now, the Morningstar US Market Index, which is our broadest measure of the overall market, is down about 2% year to date. Value stocks are actually up 4.2%, whereas growth stocks are down almost 6.0%.
Dziubinski: Has Morningstar yet made any changes to its fair value estimates on companies because of the tariffs?
Sekera: Not yet, and in my mind, I just don’t think there’s enough specificity and clarity as to what the final resolution is going to be on all of the tariff negotiations that are going on. To incorporate those potential changes in tariffs into valuations, there are a lot of things that we need to know. We need to know what products are included, what products might be excluded, what the amount or the percentage of the tariffs are going to be. We need to have an idea of how long we think that they’re going to be in place, and of course, what kind of retaliatory tariffs might be put in place as well. In my own mind, when I’m thinking about what’s going on right now, thinking about the existing 25% tariffs on Canadian and Mexican products and goods, I just don’t think that’s going to be what the final tariffs are going to be once this is all settled.
Dziubinski: Last week we also had jobs numbers come out, and they came out lower than expected. Unpack them for us.
Sekera: Payrolls came out at 151,000 as you noted, slightly less than what expectations were. I would just say at this point, in our view, it’s still too early to see the impact of potential job reductions across the federal government departments. When you get into the underlying numbers here, the government sector actually added 11,000 jobs in this last payroll report, even though you had federal government payrolls declined by 10,000. So I think next month is where we probably first really start to see that potential impact. Looking at some of the other indicators here, the unemployment rate came in at 4.1%, a little bit higher than the 4.0% in the last report. But really, as you know, the thing I consider to be most important right now to the markets and the economy is going to be wage growth. That did come in 4% year over year, slightly lower than expectations but still ahead of core PCE, which was 2.6% on a year-over-year basis earlier this month. To me, that is a positive development. I still think we need to see additional wage growth just in order to help increase purchasing power among households, especially in lower-income and middle-income households.
Dziubinski: Dave, what impact do you think these jobs numbers will have on the Fed’s rate decision at the March meeting?
Sekera: I don’t think it’s going to make any impact. I don’t think we’re looking for a change at the federal-funds rate in the March meeting. It looks like the market implied probability of the Fed cutting in May is a little bit under 40% right now, but I know our US economics department is still looking for a 25-basis-point cut in May.
Dziubinski: Let’s shift over to this week now, and we have February CPI and PPI numbers coming out. What’s the market expecting and is it likely that tariff talks will have any impact on those numbers?
Sekera: I don’t think there’s going to be much impact at the tariff talk just yet, but CPI is expected at least to be moving in the right direction. I think consensus for headline CPI on a year-over-year basis is 2.9%, a little bit lower than the prior 3.0% print, and then core CPI coming out at 3.1% on a year-over-year basis, so better than the 3.3% we had last month.
Dziubinski: We have a couple of companies reporting this week that you’re keeping an eye on. The first is Dollar General DG. The company’s been under pressure due to a couple of different factors. Tell us about that.
Sekera: This has been a multiyear story in how it’s playing out. So Dollar General initially did OK when inflation was increasing back in 2021 and 2022. Cash-strapped consumers were switching to dollar stores, and inflation at that point in time was reducing purchasing power. And so consumers were only able to buy smaller individual units at a time. As inflation continued to compound itself in 2023 and 2024, consumers were feeling even more and more purchasing power reduction for what they’re able to spend coming out of their wallet. So, as such, what we saw was that consumer spending had become much more focused on consumables such as food and less on discretionary items. And unfortunately for the dollar stores, food is a lower-margin business, discretionary is a higher-margin business. So, you had this negative mix shift which hit their operating earnings and of course hit their bottom line as well.
Dziubinski: Dollar General’s stock is down 47% over the past year. Looks really undervalued according to Morningstar today. What’s your take on it ahead of earnings?
Sekera: It does. It trades at a 29% discount. It’s a 5-star-rated stock, still provides just under a 3% dividend yield. It is a company we rate with a narrow economic moat. We have a Medium Uncertainty Rating on the stock. So, I think the longer term investment thesis here is there is upside once consumer purchasing patterns begin to normalize as wage inflation helps restore that purchasing power. Now, I have to admit the stock was up like 7.4% last Friday. I did a quick search. I don’t know why; I didn’t find any actual news that I thought would make it move up that much. It could mean a couple of different things that might be going on coming into earnings. Maybe someone for some reason thinks the earnings are going to look really good this quarter, and so they’re trying to get ahead of that. Again, I would just note that this might introduce some added volatility to this earnings report when you have a movement like that coming into the earnings release because, of course, if the earnings for whatever reason are disappointing, that could lead to a pretty quick selloff after that big bump in the stock price.
Dziubinski: Well, then it’s definitely one to watch. All right. We also have Adobe ADBE, which is a stock we’ve talked about on The Morning Filter several times before reporting earnings this week. Now the stock fell hard last quarter after issuing a disappointing outlook for fiscal 2025. What will you be listening for in the report?
Sekera: Specifically, I’ll be listening for how they’re utilizing AI in order to help drive pricing increases as well as being able to drive new consumer growth. Now, generally their new products have been gaining traction, specifically the Acrobat AI assistant and their GenStudio, as well as Firefly. I know that Dan [Romanoff], who covers the stock for us, has specifically noted he thought Firefly is well-positioned in artificial intelligence. I’ll also be listening for additional color on how the company is faring using pricing as a lever within their tiered structure really for their core AI applications, and the recent price increases and product launches and some rapid GenAI adoption we think generally is going to drive pretty good growth this year.
Dziubinski: Then what’s Morningstar think of Adobe’s stock heading into earnings?
Sekera: It’s currently a 4-star-rated stock at a 24% discount. It doesn’t pay a dividend, so not necessarily appropriate for dividend investors, but it is a company we rate with a wide moat, although as with a lot of software and technology stocks, it does have a High Uncertainty Rating.
Dziubinski: All right, moving on to some new research from Morningstar. We had Broadcom AVGO reporting earnings last week, and the stock rallied afterward. What did Morningstar think of the report?
Sekera: Earnings and guidance for AI revenue did beat our expectations by a little bit. Overall, revenue came in 25% up year over year, 6% sequentially, and revenue tied specifically to AI we think rose 15% sequentially. So when you take a look at the company’s guidance, we think that implies flat sequential revenue growth, but a 7% sequential growth rate in AI revenue. Now, I’d also have to highlight here, too, we did raise our Uncertainty Rating to High, and the reason for increasing that is the concentration of AI is becoming a higher percentage over their overall results. And so as such, we think that deserves that high uncertainty rating now.
Dziubinski: Is there an opportunity here today? Did Morningstar make any fair value changes to Broadcom’s stock?
Sekera: We did, but I would say it was pretty minor. It was only a 5% increase up to $200 per share for our fair value. Right now it looks like the stock is trading pretty close to that, so it puts it in that 3-star territory.
Dziubinski: We talked on last week’s episode about how overpriced Costco COST was heading into earnings, and the stock did pull back after the company reported a revenue beat but an earnings miss. What was Morningstar’s take on the results?
Sekera: Overall the results were pretty good. When you look at comp-store sales, they were up 9%. That was a combination of a 6% growth in traffic and a 3% growth in their average ticket. And just to put that into comparison, Walmart WMT was up 4.6%, and Target TGT was only up 1.5%. So, a big increase in comp-store sales, profitability expanded a little bit, increased 10 basis points. So, the op margin went up to 3.6%, but this is still one of the more overvalued stocks, in our mind. So, again, fundamentally the company is doing extremely well, but we think the market is just over extrapolating this short-term growth too far into the future.
It’s currently a 1-star stock trading at a 72% premium. Just to put that in context, it trades at about 55 times our fiscal 2025 earnings estimates. So, way up there as far as valuations go, and just when I take a look at our model here, and I don’t think we’re necessarily being overly cautious, we’re forecasting comp-store sales growth of fiscal 2025 still of 7%, much better than a Walmart or a Target. And then over the long term, we’re still modeling in comp-store sales growth in kind of that mid-single-digit over the long term. We’re still looking for continued increases in the operating margin. We’re looking for that to get up to 5% by 2034. As you noted, the stock did finally start falling. So, I don’t know if maybe this is now finally the point that stock starts to roll over and maybe starts continuing on a downward trend.
Dziubinski: All right. We also had a couple of names in cybersecurity, CrowdStrike CRWD and Zscaler ZS, report last week, but their stories were different. CrowdStrike stock tumbled after earnings, but Morningstar raised its fair value estimate on the stock, and then, meanwhile, Zscaler rallied after earnings and Morningstar held its fair value. Explain it all for viewers, Dave.
Sekera: Well, the stock prices did move around a bit, but fundamentally nothing really changed that was significant enough from our expectations to really change our mind on cybersecurity, and cybersecurity stocks overall. CrowdStrike reported solid fourth quarter earnings that included sales growth of 25%. Now, operating margins here did contract, but a lot of that was just due to higher operating costs following their outage in July. We think over time those operating costs will normalize. In our view, the stock had probably gotten ahead of itself, and at this point we just think that lower margin probably drove that negative sentiment here in the short term. Taking a look at Zscaler, similar in that revenue growth was up by 23%, but as you noted, it was different in that the margin there did expand, but overall fundamentally, not really a lot changed in our outlooks.
Dziubinski: After all that, both stocks still look fairly valued, so there’s no buying opportunity in either right now, right?
Sekera: Correct. They’re both rated 3 stars. In the case of CrowdStrike, it’s trading pretty close to our fair value after the stock fell. And then as far as Zscaler, again pretty close to our fair value after that stock price rose.
Dziubinski: We had a question come in from a viewer about Polaris PII, which has been an undervalued stock with a 5-star rating that you and I have talked about before on the show. Now, the company reported pretty dismal earnings a few weeks ago and offered a weak forecast. So, our viewer Gerard asked if Morningstar had changed the rating and the fair value estimate on the stock after the report.
Sekera: The rating is still the same. It’s still a 5-star-rated stock, trades at a 36% discount from our current fair value, and it looks like the dividend yield there is 5.6%. But we did take a pretty good haircut to our fair value, taking it down to $75 a share from $110. So, again, I think generally we knew and we understood and we incorporated within our model that there was a lot of pull-forward during the early parts of the pandemic, but at this point it just appears that it’s taking much longer than what we originally expected for the fundamentals really to improve. The shares are still undervalued here, but just taking a look at the story, this might be one where it probably takes another couple of years for it to really begin to play out. This is probably better for patient investors that can wait out this short-term period of slower-than-expected fundamental improvement.
Dziubinski: Now, as you pointed out, even after that cut in fair value, the stock still has a 5-star rating. So with the change in fair value, the rating didn’t change. Can you briefly explain to viewers and listeners how that works?
Sekera: Essentially, it’s just as simple as that stock was trading at a much larger margin of safety from our prior fair value estimate, which was higher, and at this point it’s still trading at a very wide margin of safety, but that margin of safety now is less than what it was before but still enough to be able to put it in that 5-star range.
Dziubinski: You published your new stock market outlook, Dave, which viewers and listeners can find on morningstar.com. Just as we’ve seen a market rotation in terms of value versus growth this year, we’ve also seen a rotation in the markets this year by sector. Recap that for us.
Sekera: And a lot of that does have to do with growth stocks overall selling off and value stocks appreciating, and just depending on where those stocks are within the different sectors, generally we’ve seen our sector valuations consolidate toward fair value. Essentially, overvalued sectors have become less overvalued, undervalued sectors less undervalued. For example, taking a look at healthcare, real estate, basic materials, those were some of the more undervalued sectors at the beginning of the year. Each of those now has moved closer toward fair value, and then among the overvalued sectors at the beginning of the year, for example, like consumer cyclical was the most overvalued and has since dropped all the way toward our fair value composite.
Dziubinski: You say in your outlook that there are a couple of sectors that have kind of bucked those trends. Which ones are they?
Sekera: Bucking the trend that we’ve seen thus far is going to be the communications sector and consumer defensive sector. Now communications has become more undervalued following a couple of pretty notable increases in our fair values on stocks such as Alphabet GOOGL and Meta META. Of course, those are by market cap, the largest stocks within that sector by percent. And then consumer defensive has also become further overvalued. It’s now the most overvalued sector at a 17% premium. But, again, I also have to note that the three stocks in that sector that account for the greatest percentage of the market cap within the sector are Walmart, Costco, and P&G PG. And each has risen 7%, 12%, and 9% through the end of February. But those are three stocks that we think are pretty overvalued with Walmart and Costco both being 1-star-rated stocks; P&G being a 2-star-rated stock. Once you get away from those three companies within the consumer defensive sector, we see a lot of value there. This is one where it’s much more of a stock-picker’s market looking for those companies in consumer defensive, such as a lot of the food companies that we think are undervalued today.
Dziubinski: So, consumer defensive stocks as a group look overvalued. What other sectors look overpriced today?
Sekera: First, I’ve got to point out the financials, trading at a 14% premium. In this case, a lot of the big, mega US banks are trading at high premiums like JP Morgan JPM. The insurance companies, we also think are trading too high at this point. Utilities still a bit overvalued at an 8% premium. And then lastly, the industrial sector at a 4% premium.
Dziubinski: You mentioned that the communications sector has become more undervalued. Any other sectors look like bargains today?
Sekera: I still like energy at a 8% discount, a lot of opportunities there, and real estate at a 6% discount, although I would be a little bit more stock selective in the real estate sector, probably still steering clear of the urban office space, but looking for the real estate that has much more defensive characteristics.
Dziubinski: All right, well we’ve arrived at the stock picks portion of the program, and your picks this week are undervalued stocks of companies that have economic moats and decent yields and that look like opportunities in a market where there’s a lot of noise, like today’s market. Your first pick this week is Verizon VZ. Run through the numbers on it.
Sekera: Verizon’s a 4-star-rated stock. Again, it just popped 4% last Friday. I don’t know if that’s just a matter of people looking for a value-oriented stock with a high dividend, but at this point it’s still at a 13% discount to fair value. The dividend yield now has slipped below 6.0%, looks like it’s at 5.9%, but it is a company we rate with a narrow economic moat based on its cost advantages and its efficient scale, and a stock we rate with a Medium Uncertainty.
Dziubinski: As you mentioned, Verizon’s stock was up last week, but it’s also up 17% this year—not too shabby. Yet, it still looks undervalued. Why do you think the stock has more room to run?
Sekera: Yeah, and we’ve recommended both Verizon and AT&T T stock a number of times. I think the first time we really reviewed both stocks was in spring of 2023, and we’ve reiterated our recommendations there a couple of times. Although I’d note at this point AT&T has moved up enough that I believe it’s a 3-star-rated stock. The original thesis here was that the wireless business overall was becoming much more like an oligopoly. That over time, we expected them to compete less on price, that would then allow margins to expand. And that has been coming to fruition. Since our first recommendations, AT&T has just well outperformed Verizon. It just appears that the market prefers AT&T’s strategy of building out their own fiber assets as opposed to buying them, which is what Verizon has been doing.
But either way, over the longer term, I still think that it’s going to be the same kind of factors that affect both companies. And, in fact, with as much as AT&T has moved up, I wouldn’t be surprised to see some investors that maybe swap out of AT&T into Verizon instead. In my mind, that swap makes sense. You pick up yield and you buy at a greater discount to fair value. It looks like Verizon reported earnings in January. I think our takeaway here was that they were solid, although not necessarily anything to write home about. In my mind, I think this is just a solid value stock pick with a great yield carry at this point.
Dziubinski: Now your second pick this week is FirstEnergy FE, which also has a pretty attractive yield.
Sekera: Four-star-rated stock, 12% discount, 4.4% dividend yield, like pretty much all the other regulated utilities, narrow economic moat and a Low Uncertainty.
Dziubinski: The utilities sector is overvalued, yet FirstEnergy looks undervalued. What’s the market missing here, Dave?
Sekera: It’s just missing just how focused the company is on accelerating investments that should result in solid earnings growth over the long term. I think our current model is that we expect FirstEnergy to invest $26 billion through 2028. That’s a 40% increase from their previous five-year capital investment plan. That just supports our expectation that the company can achieve at least the midpoint of the management’s annual earnings growth targets. Specifically, this company serves states like Ohio, Pennsylvania, and New Jersey. We think, overall, Ohio and Pennsylvania have higher probabilities of seeing new data center buildouts in order to support AI. They just have relatively strategic locations, economic incentives, and the infrastructure to do so. And somewhat similar to Wisconsin—and again, we’ve talked Wisconsin Energy or Wisconsin Electric over time as well—it’s of course easier to keep data centers cool in the northern states than in the southern states. I do think the company reports earnings here relatively soon. There’s always, of course, the risk that something unexpected comes up, but we think it’s probably more likely a higher probability of upside surprise than negative news.
Dziubinski: Your next pick this week is U.S. Bancorp USB. Walk through the key metrics on this one.
Sekera: Four-star-rated stock, 16% discount, 4.5% dividend yield. We rate the company with a wide economic moat, and, in fact, I think it’s the only regional bank that we rate with that wide moat and it has a Medium Uncertainty.
Dziubinski: Here again we have another example of a stock in an overvalued sector—and in this case it’s financial services—that looks undervalued. How does Morningstar’s thesis on U.S. Bancorp differ from that of the market’s?
Sekera: Actually, I don’t think we’ve talked about U.S. Bancorp in quite a while now. This originally was one of our better picks after the Silicon Valley bank failure back in March 2023. If you remember, at that point in time, the entire banking sector sold off too hard. There was a lot of very undervalued bank stocks at that point in time. Over the time period since then, the stock did move up enough that it got into 3-star territory by last fall. But what we’ve seen is regional banks generally started sliding earlier this year, and even since mid-February, a lot of the US mega banks have been sliding as well. To some degree, I think the market is pricing in fewer rate cuts than what we had expected or what the market had expected before. So, again, you’ll get less of an increase in net interest margins over time.
Plus, the market just might be getting more concerned that a softer and softer economy could lead to higher charge-offs as well. In that environment, the regionals have fallen more than the mega banks, generally just because the regionals have fewer nonbanking revenue streams, such as investment banking, that you’d see at the large banks. Then specifically looking at U.S. Bank, it does have some of this fee income, though, that we think will help provide better downside protection than the other regionals. So, they do have revenue from corporate trust fees, they have a pretty strong deposit franchise. And just fundamentally, we think it has one of the best operating efficiency ratios, according to our numbers, compared to the other regional banks. So again, U.S. Bank, in particular, I think the market might be a little apprehensive following the announcement of a transition of the CEO. There was no prior retirement timeline given for that, but we’re not as worried. The new CEO is coming from within the company and we don’t think it’ll be too disruptive to their operations.
Dziubinski: Your last stock pick this week is an undervalued stock from the consumer defensive sector. It’s Clorox CLX. Tell us about it.
Sekera: So, 4-star-rated stock at a 13% discount, 3.2% dividend yield. Again, a company we rate with a wide economic moat based on its intangible assets and its cost advantages, and the stock we rate with a Medium Uncertainty.
Dziubinski: Clorox stock peaked during the pandemic as we were all hoarding the company’s cleaning products, and the stock has since pulled back. Why is this a pick today?
Sekera: To some degree, I’m literally thinking about this as being a normalization play. As you mentioned initially, you had just outsize growth those first couple of years after the beginning of the pandemic, and it’s given back a lot of that growth ever since then. Then, of course, you had to deal with all the shipping issues, the supply bottlenecks in 2022. Unfortunately, the company did suffer from a cybersecurity breach in 2023, which took some systems offline for a while. Again, just another good reason for owning some of those cybersecurity stocks. And then thinking about what happened in 2024; the company did have to increase their promotional spending just to be able to maintain their brand strength, which our analyst has noted. She thinks that that is working.
In fact, the Clorox brands are holding up pretty well here in the short term, even in the face of heightened competition from private-label brands. We think that indicates that consumers do give added economic value to the Clorox brands.
And just generally, when I look at that stock price, it’s essentially now unchanged from where it was trading prepandemic. So, it’s done pretty much a full round trip at this point. I took a quick look at our model this weekend. We’re not predicting any big huge shifts here. We’re looking for top-line growth in that low-single-digit percentage area. We are looking for some slight operating margin expansion over time. Now the stock is trading at 21 times its midpoint for 2025 earnings guidance. I would note their fiscal year-end is here in June. Once we get closer to that, then I think the focus will be not so much on that forward multiple for fiscal ’25 but the forward multiple for 2026, which at that point in time should be below 20. From that market point of view, I think it’ll look more undervalued at that point in time. Now, historically, not necessarily cheap here, but when you look at where it’s traded on a historical basis on a valuation, it does look undervalued to us here.
And then lastly, as far as tariff goes, Erin Lash, who covers the stock for us, did write in her last note that she didn’t expect that tariffs would have much of a negative impact on Clorox. And then lastly, I have to note too, it does have a pretty strong balance sheet. So, if we are going into any kind of downturn, this is a stock and a company that should be able to weather any kind of economic noise over the next couple of quarters.
Dziubinski: All right. Well, thank you for your time this morning, Dave. Those who’d like more information about any of the stocks Dave talked about today can visit morningstar.com for more details. We hope you’ll join us next week for a new episode of The Morning Filter on Monday at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this episode and subscribe. Have a super week.